Can Railroads Replace Coal With Chemicals? Not For a While

Written by Jim Blaze, Contributing Editor
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Since railroad freight is often bulk or shipments of large goods, changes in the economy or in global trade can impact the flow of railroad traffic in large up and down movements. Translation: There will often be cyclicality.

The upside outlook and long-term pattern of market demand for chemicals is still strong. But 2019 proved that nothing is guaranteed. Table 1 gives us a picture of the recent changes of chemical rail volumes vs. several other commodities. There is variance both by time period and among the commodities. It reflects the complexity of the markets over time.

Table 1: North American rail volumes by selected markets, year over year percent change for that quarter.

While the prospects for more chemical business are still positive, the growth will not be the same across the North American market. There will be pockets of regional growth. Figure 1 was discussed with groups of shippers and transport carriers at the 2019 FTR conference. It identifies the strength of the chemical railroad volume across a wide geography. There is variance in the volume. (FTR makes such exhibits available to FreightWaves participating journalists.)  

Figure 1: FTR pattern analysis identifies some of the cyclicality in chemical transport.

The chemical industry sector is, however, linked to selected high-density traffic and energy supply regions. It is those regions that will provide ample supplies of petroleum and natural gas. Those are the essential feedstocks for the petrochemical business. 

The high growth regions will be near Texas and the Western Pennsylvania/Ohio shale oil fields. That is where the large chemical plant processing will occur, and where the railroads will get their opportunity to move the petroleum industry’s downstream products. It is likely that New Jersey will also benefit from the relatively nearby shale fields as feedstock for the Philadelphia region. These regions of the U.S. offer a relatively cheap energy supply. That is indeed a strategic advantage. 

There are possible exceptions. For political reasons, it appears that New York State has decided not to participate in the job creation/industrial development opportunities from its oil and gas fields. 

Let’s acknowledge the market risk side. There is a cyclical pattern to chemical movements as shown in Figure 2 by car type. Other graphs would show similar fleet size back-order variances for railcars like those used for frac sand. There is also an element of trade geopolitical risk.

Figure 2: Illustration of the variance across six North American railroad freight car types in the period 2013 to mid-year 2019.

Then there are the peculiarities of railroad operations and rail freight car utilization. Chemicals often move differently than other rail shipments. Railcar utilization is often not at all the primary interest of the shippers leasing or owning chemical and resin cars.

For example, plastic pellet covered hoppers might typically make only as few as four loaded turns per year. Why so few? Because to shippers, the railcar is more valuable as a forward-logistics warehouse. The manufacturer is interested in being able to quickly respond to a regional surge in market demand for specific commodities that are remote from the manufacturing plants. Thus, a car loaded with plastics or other chemical products can sit in storage yards for three months or more. The yards are called SIT (storage-in-transit) terminals. This is a warehousing logistics practice. 

There is quite a bit of SIT terminal use. Some railcar builders estimate that perhaps as many as 1,000 railcars are required to transport one billion pounds of plastic produced by the petrochemical plants. 

Perhaps some of this utilization will soon improve, as the railroads using PSR (Precision Scheduled Railroading) show evidence of much improved railcar cycle times for the chemical sector. 

As shown in Table 2, the railcar types in the North American fleet that are the most profitable investment in terms of estimated revenue are covered hoppers for plastics and grain.

Table 2

Table 3, the relative annual volume size of selected carload commodity markets, is an easy reference about the carload business. Chemicals as a sub-market is large, at almost 13% of total carloads across the Canadian, Mexican and U.S. track network. Coal is still number one in carloads moved. Though coal traffic has dropped substantially, it has not disappeared.

Table 3

Figure 3 is a SONAR graph that depicts the carload difference between coal and chemical traffic. Coal obviously dominates—for now.

Figure 3: Comparison of chemical and coal volumes in 2018 and 2019, in millions of carloads. Sources: AAR data and FreightWaves SONAR.

Into 2020

As we move deeper into 2020, what is the 12-month outlook for the chemical sector? Trade headwinds that slowed chemical exports for U.S. companies during 2019 may now shift a bit. If China, for example, increases imports of liquefied natural gas and petrochemicals from the United States, there should be year-over-year growth for U.S. railroads. That might appear in the monthly statistics by early April 2020.

There are very few published chemical logistics surveys yet, but it appears logical that a 3% to 5% year-over-year increase in rail-hauled chemicals could occur, assuming that China does not face internal recession impacts.

The impact on domestic U.S. rail chemical traffic will likely be signaled by announced Chinese orders. How much China might purchase from U.S. sellers is not yet known from the Phase One agreement between the U.S. and China. Even Wall Street pundits seem to be speculating for the moment.

Remember that some of the U.S. exports to China will be subject to better pricing offered by other global sources. Currently, there is insufficient trade data to know.

The first solid signals of impact on the U.S. railroad sector will likely come from new railcar orders for tank cars and covered hopper. Unclear at this point are the petrochemical shippers and receivers that will start to acquire more railcars from lessors. (Remember that Class I railroads generally don’t own or lease these kinds of railcars.)

Is it possible that shippers might need to order fewer cars? Is PSR working so well that car utilization has soared? Reviewing a variety of sources suggests that there is no clear-car cycle evidence yet. According to shippers, some certainly have adapted to PSR’s fixed schedules and occasional car delivery bunching. Some like the consistent reorganizing of train movements into seven-day service operating plans rather than the older, five-day service plans. Others complain that their rail sidings simply cannot easily or cheaply adapt to the PSR service changes—not without shipper-borne capital expenditures. The jury seems to be still deliberating regarding customer PSR benefits.

The Rail Equipment Finance 2020 conference in early March should give a solid outlook as to the trending chemical rail sector for the next 24-month period. Someone, somewhere is preparing that kind of specific outlook. They must do this, because so many financial houses show up at REF that write the checks for this equipment. The new railcar buyers have about 30 days to get that message into their slides and then stand before an audience that builds and finances.

My experience says that chemical sector decision-makers will reflect conservative outlooks. Few want to go first. For three days at REF, the participants will be “testing the water.” After all, every 1,000 new railcars represent a cost exceeding $120 million. Railcars last around 40 years. So, there is not a lot of room for error.

As always, contrary logic is welcomed.

Acknowledgements

These references below might not agree with my interpretation of the markets. They are nevertheless valuable to you, the reader, as alternative viewpoints and sources of evidence:

  • David Humphrey, Ph.D, Railinc; 2019 North American Railcar Review; REF2019.
  • Dan Penovich, President, Mitsui Rail Capital, LLC
  • Jay Carter, Strategic Market Manager, The Greenbrier Companies.
  • David Nahass, President, Railroad Financial Corp., and Railway Age Financial Editor.

Independent railway economist, Railway Age Contributing Editor and FreightWaves author Jim Blaze has been in the railroad industry for more than 40 years. Trained in logistics, he served seven years with the Illinois DOT as a Chicago long-range freight planner and almost two years with the USRA technical staff in Washington, D.C. Jim then spent 21 years with Conrail in cross-functional strategic roles from branch line economics to mergers, IT, logistics, and corporate change. He followed this with 20 years of international consulting at rail engineering firm Zeta-Tech Associated. Jim is a Magna cum Laude Graduate of St Anselm’s College with a master’s degree from the University of Chicago. Married with six children, he lives outside of Philadelphia. “This column reflects my continued passion for the future of railroading as a competitive industry,” says Jim. “Only by occasionally challenging our institutions can we probe for better quality and performance. My opinions are my own, independent of Railway Age and FreightWaves. As always, contrary business opinions are welcome.”

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